The pace of growth and improvement across emerging markets means investors in this area need to constantly evolve their process to keep up with the changing landscape.
This is according to Chetan Sehgal, manager of the Templeton Emerging Markets Investment Trust. Although Sehgal has only been the named manager since January 2018, he has worked on the trust since 1995.
Emerging markets have been transformed over this time, and Sehgal said what worked in the 1990s did not work in the 2000s and what worked in the 2000s did not work in the 2010s.
Performance of trust vs index over 20yrs
Source: FE Analytics
“When we started off, it was a pure country-based approach, so all the analysts were looking at companies within the country they visited, but now it is more focused on sector research, companies are competing with each other [internationally] and that wasn't the case before,” he said.
Sehgal added that the early investment opportunity to buy into emerging economies was “no longer there”, with the early-stage disruptive companies of the early 1990s a thing of the past.
Today, he argued investors needed to focus more on the global competition, as well as keeping an eye on technology that would become obsolete and the new age of premium access which has risen over the past decade.
As a result, Sehgal said investors in emerging markets today needed a deeper understanding of the companies and sectors they were investing in, with much shorter life cycles making it more important to back the right management teams.
In addition, he said they also need to keep an eye on the way government policy is evolving in individual markets, which makes it important to have staff with local knowledge.
Most important though is the quality of the underlying businesses being invested in.
“Over a period of time, you realise that the best way to make money in emerging markets is to buy these companies which have sustainable advantages and then own them for the longest period possible, because churn actually doesn't help,” Sehgal said.
“You want to own them for the long term and you want companies that are not only doing well presently but have a roadmap to do well in the future.”
The changes in emerging markets over the past 25 years have meant much of the easy gains have been made and it is now more challenging for active managers to outperform. However, Sehgal said many of these changes have worked in investors’ favour too, such as improved corporate governance.
“It is much better since the 1990s, but there's still been a loss to shareholders over the past 20 years because of poor corporate governance, such as fraud – for example in 2009 there was the case of Satyam Computers.”
The Indian company’s founder-chairman, Ramalinga Raj, admitted to false accounting with a $3bn (£2.2bn) fraud.
Corporate governance improvements have been aided by the introduction of internationally accepted accounting practices, simplifying comparisons between companies in different countries. Yet Sehgal said many of the changes have been brought about by the businesses themselves.
For example, he said they have begun to pay more attention to environmental, social and governance (ESG) factors to prevent a potential hit to their profits in the future.
They have also realised that favouring majority shareholders over minority ones is not a good tactic for attracting future investment.
“One of the ways corporate governance used to take away from shareholder returns in the past was dilutions,” he continued.
“Some UK-listed multinational companies back in the 1990s issued shares in their subsidiaries at discounted prices to increase their stake. But things have changed. With more transparency, we believe we can make more gains for the minority shareholders in the future.”
Meanwhile Sehgal and other fund managers have been working with companies to encourage them to return excess cash back to shareholders in the form of dividends.
Despite these improvements, Sehgal said the emerging markets story was still not widely accepted by investors. Aside from concerns over corporate governance, he said there was also a perception that emerging market businesses were not as robust as those in the developed world. Again though, this has been changing.
“We are seeing a new breed of companies getting listed which are very, very competitive. And I think that is something which is also driving the growth of their countries. That's what happened with the internet in many of these emerging markets, and many more sectors.
“There's a lot of vibrancy which is being missed by people,” he finished.
Data from FE Analytics shows the Franklin Templeton Emerging Markets Investment Trust has made 30.3% since Sehgal took charge in January 2018, compared with gains of 14.1% from the MSCI Emerging Markets index and 9.7% from the IT Global Emerging Markets sector.
Performance of trust vs sector and index under manager
Source: FE Analytics
The trust is on a discount of 6% compared with 26.8% and 16.7% from its one- and three-year averages.
It has ongoing charges of 0.97%.